The Critical Vendor Doctrine after Kmart...2 If so, in which courts; and what is the standard the...
Transcript of The Critical Vendor Doctrine after Kmart...2 If so, in which courts; and what is the standard the...
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The Critical Vendor Doctrine after
Kmart CAN YOU STILL GET PAID NOW, IN FULL,
ON YOUR BANKRUPT CUSTOMER'S ACCOUNT?
3rd Edition
The
Credit
Research
Foundation
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The Critical Vendor Doctrine After Kmart CAN YOU STILL GET PAID NOW, IN FULL,
ON YOUR BANKRUPT CUSTOMER'S ACCOUNT?
By:
Scott Blakeley, Esq.
2 Park Plaza, Suite 400,
Irvine, California 92614
V. (949) 260-0612 | F. (949) 260-0613
[email protected] | www.BlakeleyLLP.com
Orange County | Los Angeles | New York | Delaware
Copyright 2013 by the Credit Research Foundation.
All rights in this publication are reserved.
No part of this publication may be reproduced in any manner whatsoever without written permission.
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ABOUT THE FIRM Blakeley & Blakeley LLP represents its creditor clients in the areas of creditor rights, commercial litigation and collection, credit documentation, e-commerce, bankruptcy and out-of-court-workouts. B&B’s collective experience and legal and practical understanding of vendors’ rights results in cost-effective representation and develops solutions to vendors’ problems. B&B’s attorneys have extensive experience working with vendors. Members of the firm routinely speak to national industry groups and trade associations concerning creditors’ rights and frequently publish articles in national and regional publications concerning creditors’ rights. Scott E. Blakeley, Esq. is a graduate of Pepperdine University, and holds an M.B.A. From Loyola University and a Law Degree from Southwestern University. He has served as law clerk to Bankruptcy Judge John J. Wilson. Scott advises companies around the country regarding creditors’ rights, commercial, e-commerce and bankruptcy law. Credit Today selected him as one of the 50 most influential people in commercial credit. Mr. Blakeley is a prolific writer and has produced a series of publications for the Credit Research Foundation specifically related to bankruptcy issues as well as other legal matters. Scott is contributing editor of NACM’s Credit Manual of Commercial Law; and has published dozens of articles and manuals in the area of creditors’ rights, commercial law and bankruptcy in such publications as Business Credit, Managing Credit, Receivables & Collections, Norton’s Bankruptcy Review and the Practicing Law Institute, and speaks frequently to credit industry groups regarding these topics throughout the country. He is a member on the board of editors for the California Bankruptcy Journal and is an editorial advisor for Credit Today. Other Credit Research Foundation Publications by Scott Blakeley The Credit Research Foundation is grateful to Mr. Blakeley for his untiring quest to help credit professionals in the area of creditor’s rights and legal matters. Scott has written several monographs that CRF has published in the last few years specifically involved with bankruptcy and dealing with distressed debtors. All CRF publications are sent to each CRF PremierPlus, Premier and Corporate members. Also, they are available for sale through the CRF Publications Bookstore at www.crfonline.org.
The Credit Professional’s Guide to Bankruptcy The Credit Professional’s Guide To Creditors’ Committees in Chapter 11 Commencing an Involuntary Bankruptcy The Credit Professional’s Preference Manual Credit Enhancements & Alternative Payment Mechanisms
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Table of Contents:
A. History of the Critical Vendor Doctrine _______________________________________________________ 2
1. The Equality of Payment Rule for Unsecured Creditors in Bankruptcy _______________________________ 2
2. Development of the Necessity Doctrine _______________________________________________________ 2
3. The Necessity Doctrine Outside of Railroad Reorganizations ______________________________________ 3
4. The Modern Approach to Critical Vendor Payments ______________________________________________ 3
B. The Critical Vendor Doctrine ______________________________________________________________ 4
1. Types of Products or Services that may be Deemed Critical _______________________________________ 4
2. The Trade Claims Cap ___________________________________________________________________ 6
C. Criticism of the Critical Vendor Doctrine _____________________________________________________ 6
D. The Kmart Rulings: From the Bankruptcy Court to the Supreme Court _____________________________ 7
1. Bankruptcy court's Authorization to Pay Critical Vendors _________________________________________ 7
2. Capital Factors Objection to Paying Critical Vendors _____________________________________________ 7
3. The District Court Reverses the Bankruptcy court _______________________________________________ 7
4. Seventh Circuit Court of Appeals Affirms the District Court and Limits the Critical Vendor Doctrine _________ 8
5. The Supreme Court requests by creditors to consider the Seventh Circuit’s ruling in Kmart. _______________ 9
6. Kmart’s Claw Back (reach back) of Critical Vendor Payments ____________________________________ 10
E. Special Issues with the Critical Vendor Doctrine ______________________________________________ 10
1. Reorganizing Versus Liquidating Debtors ____________________________________________________ 10
2. Making The Critical Vendor List ____________________________________________________________ 10
3. Selling To A Chapter 11 Debtor Invoice By Invoice Compared With An Executory Contract ______________ 12
4. Non-Critical Creditors And Shareholders Viewpoints ____________________________________________ 13
5. Persuading The Bankruptcy Court __________________________________________________________ 14
6. 503(b)(9) and Early Payment in Exchange for Trade Credit ______________________________________ 13
7. Postpetition Credit Sales: How Much Credit And Terminating The Credit Relationship __________________ 19
8. Waiving Alleged Preference Claims ________________________________________________________ 199
9. Interplay Of Reclamation _________________________________________________________________ 20
10. A Debtor’s Or Trustee’s Right To Claw Back Critical Vendor Payments Upon Reversal Or Conversion To Chapter _________________________________________________________________20
11. Failing To Qualify As A Critical Vendor; Or, The Critical Vendor Program Is Not Approved ______________ 20 12. Other Considerations for Critical Vendors____________________________________________________ 21
F. Conclusion ____________________________________________________________________ 21
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The Critical Vendor Doctrine After Kmart Can You Still Get Paid Now, In Full, On Your Bankrupt Customer's Account?
Scott E. Blakeley
The credit professional well knows that a customer’s Chapter 11 means long delays
before receiving any payment on the prepetition account; and worse, the payment is
usually but a fraction of the claim. Furthermore, it is not uncommon for the creditor to
receive stock in the reorganized debtor in exchange for its prepetition claim (as was the
case in the Kmart Chapter 11). Traditionally, the creditor would file a proof of claim,
perhaps serve on the creditors’ committee and press for a meaningful payment on their
prepetition claim. Does a creditor in this situation, especially one with a substantial trade
relationship, have any recourse? With the development of the critical vendor doctrine,
the credit professional has had a meaningful alternative.
On occasion a vendor may be a key supplier to a customer that files Chapter 11. Given
this key supplier relationship, the creditor often holds a sizeable unsecured claim upon
the Chapter 11 filing. The creditor, selling invoice by invoice (as opposed to a long term
supply contract), may elect not to continue to sell the debtor postpetition. However, the
creditor’s product or service may be viewed by the debtor as essential to its continued
operations, such as when the debtor cannot locate a substitute vendor. Without the
product or service, the debtor may be forced to close, which, contrary to the principle of
bankruptcy, may further harm the non-critical vendors. In this situation the debtor
may request that the bankruptcy court authorize it to immediately pay a critical creditor’s
prepetition claim, in exchange for that critical vendor selling to the debtor post-
bankruptcy on credit.
More and more bankruptcy courts throughout the country have been considering a
debtor’s request to treat certain vendors as critical, and have their pre-bankruptcy claims
paid in exchange for postpetition trade credit. However, as a result of the Kmart
ruling, the support of bankruptcy courts for critical vendor requests may change.
In the Kmart case, the Seventh Circuit Court of Appeals affirmed the district court’s
reversal of the bankruptcy court’s authorization for critical vendor payments. The
Supreme Court declined to hear the appeal from the Seventh Circuit. This raised the
questions:
What was the impact of the Kmart ruling on the critical vendor doctrine?
Has the critical vendor doctrine survived?
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If so, in which courts; and what is the standard the debtor and critical vendor
must establish?
A. History of the Critical Vendor Doctrine
Since the early 1990's, Chapter 11 debtors have asked bankruptcy courts to approve the
payment of vendors’ prepetition claims that the debtor believes are essential to its
ongoing operations. Payment of these claims have been allowed in the interest of
enabling a reorganization that is expected to benefit all creditors, including those that are
not designated as a critical vendor. In some jurisdictions, a motion to authorize payment
of critical vendors' prepetition claims has become a routine first day motion in a Chapter
11 case, wherein the debtor articulates its business judgment to support payment of
critical vendors.
1. THE EQUALITY OF PAYMENT RULE FOR UNSECURED CREDITORS IN BANKRUPTCY
A central principle of the Bankruptcy Code is equality of treatment of unsecured
creditors. The equality of treatment rule is embodied, for example, in the
preference laws and treatment of creditors’ claims under a plan of reorganization.
Creditors of the same priority are generally not entitled to be paid on their prepetition
claims in Chapter 11, except through a plan of reorganization; and creditors are to be
paid the same pro-rata amount on their claims in both Chapter 7 and Chapter 11 cases.
2. DEVELOPMENT OF THE NECESSITY DOCTRINE
Notwithstanding the general rule of treating creditors of the same class equally,
bankruptcy courts have often relied on the "doctrine of necessity" to allow insolvent
debtors to pay vendors whose cooperation is deemed essential to a debtor's continued
operations and reorganization. The same doctrine has been routinely invoked to justify
payment of prepetition claims such as claims of a debtor's employees for unpaid wages
and benefits.
The necessity doctrine was developed in railroad receivership cases of the nineteenth
century. Survival of the railroad industry was essential to a large segment of the
economy and communities in many regions of the United States, courts were willing to
be very flexible in allowing receivers overseeing reorganizations of railroads to exercise
remedies necessary for a struggling railroad to survive. These measures included the
necessity of payment rule, which allowed payment of certain claims that arose before
receivers were appointed. Under this doctrine, claims made by suppliers and other
entities essential to railroad operations could be paid ahead of claims that would
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otherwise have priority, including claims of secured lenders.
3. THE NECESSITY DOCTRINE OUTSIDE OF RAILROAD REORGANIZATIONS
In the twentieth century, courts began applying the doctrine of necessity to
reorganizations of businesses other than railroads, including businesses whose survival
was not necessarily linked to the public interest. The doctrine of necessity is believed by
its proponents to be incorporated within a bankruptcy court's general equitable powers
under section 105(a) of the Bankruptcy Code.
The legislative history of section 105(a) suggests that this section incorporates equitable
powers that bankruptcy courts were previously understood to possess. The United
States Supreme Court has stated that it will not read the Bankruptcy Code to erode the
past bankruptcy practice absent a clear indication that Congress intended such a
departure.
4. THE MODERN APPROACH TO CRITICAL VENDOR PAYMENTS
In the years leading up to Kmart, bankruptcy courts in a number of jurisdictions had been
inclined to authorize debtors to pay the prepetition claims of creditors deemed critical,
based on a debtor’s business judgment. The concept of "critical vendor" had gone from
an extraordinary remedy to something that was simply done as a first day motion filed by
debtors in chapter 11 cases.
However, the prevalence and ease with which creditors obtained critical vendor
payments came under increased criticism by some courts, bankruptcy attorneys and
scholars. Some critics noted that there is no provision in the Bankruptcy Code that
expressly allows for payment of critical vendors ahead of other creditors. Other critics
maintained that the Bankruptcy Code may allow critical vendor payments, but argued
that the practice had been abused with payments being authorized when a vendor is not
truly necessary to a debtor's reorganization. This criticism culminated in the Kmart
appellate rulings.
Although the Kmart opinion appeared to mark the beginning of the end for cirtical vendor
relief, trade creditors in select districts have taken shelter under section 363(b)(1) of the
Bankruptcy Code. This code section allows a debtor to use estate resources within the
ordinary course of business, which can include the payment of pre-petition claims, with
the approval of the bankruptcy court. Paramount to the approval of prepetition payments
are evidentiary hearings, the absence of which was noted in the Kmart opinion. While
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bankruptcy courts in New York and Delaware continue to permit payments to critical
vendors with oversight from the court and creditor’s committee, other courts have built
upon the Kmart decision in creating restrictive tests that are unfavorable to potential
critical vendors.
B. The Critical Vendor Doctrine
A Chapter 11 debtor that is an operating business must decide which vendors they need
most, and then negotiate a payment to them on their prepetition debt. Often, the debtor
places the "critical vendors" on a list. Those vendors that do not make the list will receive
payment through a confirmed plan of reorganization or Chapter 7 liquidation, often years
after the bankruptcy filing. The payment a “non-critical” vendor receives is but a fraction
of the claim owed; or, perhaps, stock in the reorganized debtor.
The critical vendor motion is filed by the debtor with the bankruptcy court and provides
that the vendor will receive payment on their prepetition claim. The motion also
binds the vendor to continue to sell the debtor on terms equal to or better than
prepetition terms. Prior to Kmart, the critical vendor dollar amounts sought were often
high. WorldCom, Inc., for example, was authorized to pay vendors up to $70 million. The
average relief granted to a midsized debtor ranged from $8 million to $25 million. The
responsibility to define the vendors who are critical is usually placed in the hands of the
debtor. When a company files for bankruptcy, it reviews its list of vendors and uses its
business judgment to decide which vendors are critical in order to stay in business.
1. TYPES OF PRODUCTS OR SERVICES THAT MAY BE DEEMED CRITICAL
Below are classes of products and services offered by vendors considered for critical
vendor status.
a. Vendors Providing Unique Product
A vendor providing a unique product, such as customized tooling, may qualify as a
critical vendor. This type of vendor provides some unique part for which there is no
immediate substitute vendor for the debtor. The creditor’s threat to refuse to continue to
provide its unique product creates leverage to be selected as a critical vendor. These
vendors fall into the following categories:
Sole Source Vendors: Some vendors may be a debtors’ only providers of certain
materials or services. There may be no replacement vendors for sole source vendors.
Even should competing vendors exist, a debtor may classify certain vendors as sole
source vendors where the transition to a new vendor may interrupt a debtor’s operations.
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Where a vendor is the only sole source vendor who readily can provide a debtor with
materials or services, it may refuse to continue materials or services due to the
prepetition indebtedness, and the debtor’s operations could be disrupted while the
debtor seeks to locate a substitute vendor, in excess of the amount of sole source
suppliers’ prepetition claims.
Capacity Vendors: Some vendors of materials may be the only vendors to produce such
materials in quantities sufficient to meet a debtor’s demands, even though there may be
vendors that produce some of the materials.
Quality Vendors: Some vendors may be deemed critical as they are the only vendors
that provide the debtor with certain high-quality materials. In some cases a debtor may
have customer contracts that require the high quality materials.
Knowledge Vendors: Some vendors may be deemed critical because they have unique
knowledge of a debtor’s business, or have been responsible for certain aspects of a debtor’s
business. These vendors have maintained the debtors operations for a period of time and
have acquired unique knowledge of the business. Vendors Providing Unique Service
Specialized service vendors are similar to unique product vendors, except that their
uniqueness lies in their service instead of their goods.
b. Lack of Competition within Industry
Lack of competition within an industry may give vendor leverage over the debtor and
result in critical status for the vendor. Rather than a unique product or service that a
vendor may provide, the mere fact that the vendor lacks competition creates the critical
vendor situation.
c. Foreign Vendors
Vendors that provide their product from overseas may create a critical vendor situation.
Offshore vendors may find that the debtor cannot find a replacement vendor in a timely
manner.
d. Vendors Selling to Companies Subject to Mass Tort Claims
Over the last few years, companies that used or consumed asbestos in their operations
(as opposed to manufacturers of asbestos) have been shocked to find themselves the
target of mass asbestos litigation and personal injury claims.
This mass asbestos litigation has resulted in at least two-dozen companies filing Chapter
11 to stay this litigation. In the asbestos and mass tort cases, debtors generally have
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sought critical vendor status for a large portion of its vendor class.
e. Small Vendors
Those vendors whose financial survival is dependent on the debtor paying their
prepetition claim have qualified as a critical vendor.
2. THE TRADE CLAIMS CAP
The critical vendor doctrine has evolved from the debtor requesting a particular vendor
be paid immediately as a critical vendor, to the debtor requesting a class of vendors
qualify as critical vendors, to the debtor requesting the bankruptcy court establish a
critical vendor "trade claims cap." For example, in the United Airlines Chapter 11, the
carrier requested that the bankruptcy court pay trade claims totaling $35 million as
critical. United Airlines did not identify the vendors it would deem critical. Rather, United
Airlines requested the court authorize payment of a class of vendors it deemed critical,
which represented about 14% of vendors with unsecured claims. United Airlines did not
propose to pay in full each vendor deemed critical, but only the minimum for the vendor
to continue selling on credit. In the trade claims’ cap request, the debtor may not
disclose those vendors it has selected as critical. If the debtor does dissolve, it may be
limited to disclose only to the creditors' committee those vendors it has selected as
critical. The debtor uses its business judgment as to which vendor should be deemed
critical.
C. Criticism of the Critical Vendor Doctrine
The critical vendor doctrine may be viewed as conflicting with the fundamental principle
of bankruptcy, which is equal treatment for the same class of unsecured creditors'
claims. In bankruptcy, the general rule is that vendors may be paid on their unsecured
claims only through a confirmed plan of reorganization or court authorized liquidation.
Other critics argue that courts may have the authority to allow such payments in
appropriate cases, but this practice has been over used, which has led to abuses.
Other criticism is that there are very few true critical vendors; rather, the debtor may use
the critical vendor motion to favor certain vendors. Thus, these vendors could be
substituted with limited harm to the debtor’s ongoing operations. Furthermore, if there
are indeed true vendors whose product or service is indispensable, those vendors may
have economic self-interest to continue to sell especially if the debtor has a vendor lien
program or debtor in possession financing in place. These critical vendors may sell to
the debtor with or without critical vendor status.
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Another criticism is those courts that grant critical vendor motions with a claims’ cap, turn
the approval of critical vendors over to the debtor, perhaps without creditor oversight.
D. The Kmart Rulings: From the Bankruptcy Court to the Supreme Court
Kmart’s Chapter 11 was one of the largest filings by a retailer. In an effort to obtain
unsecured credit from its vendors and maintain key vendor relationships, Kmart, in the
opening days of the bankruptcy, rewarded certain key domestic and foreign vendors with
payment on their pre-bankruptcy claims under the critical vendor doctrine. As part of its
first-day motions, Kmart filed a motion seeking authority to pay prepetition obligations to
its critical vendors. Kmart served its critical vendor motion on about 65 of its key
creditors; notwithstanding it had thousands of vendor creditors. Kmart argued these
payments were necessary to maintain business relationships with the respective
vendors, and the vendors' goods were essential to Kmart's continued operations and a
successful reorganization.
1. BANKRUPTCY COURT'S AUTHORIZATION TO PAY CRITICAL VENDORS
Vendors supplying a range of products from food to music to publishing services were
paid on their prepetition claims in exchange for these vendors providing postpetition
trade credit. The critical vendors agreed to provide credit on customary trade terms for
two years. The bankruptcy court authorized payments to the critical vendors totaling
$327 million under the “doctrine of necessity” using its equitable powers of section 105
of the Bankruptcy Code. The bankruptcy court was satisfied with Kmart’s business
judgment that without paying vendors their prepetition debt, the vendors would not make
shipments postpetition; and without these goods Kmart’s reorganization would be
threatened.
2. CAPITAL FACTORS OBJECTION TO PAYING CRITICAL VENDORS
Capital Factors (CF), a company that had factored certain vendors’ accounts
receivables, held $20 million in claims against Kmart, and was not included among the
vendors to be paid pursuant to the critical vendor motion.
CF appealed the bankruptcy court’s critical vendor order. CF complained that the
bankruptcy court had no legal basis to discriminate paying certain vendors prepetition
claims. Under Kmart’s plan of reorganization, non-critical vendors received ten cents on
the dollar, payable in Kmart stock. The District court reversed the bankruptcy court.
3. THE DISTRICT COURT REVERSES THE BANKRUPTCY COURT
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The district court acknowledged that the bankruptcy court's application of the "doctrine of
necessity" was well intended and may even have had some beneficial results. However,
the district court concluded there was no authority under the Bankruptcy Code to
afford priority status for the payment of certain prepetition obligations to vendors.
In reversing the bankruptcy court’s decision, the district court determined that such
payments were, (1) not authorized by Bankruptcy Code section 105(a)’s broad grant of
equitable power; and (2) the critical vendor payments were contrary to the Bankruptcy
Code’s priority scheme. The district court rejected the debtor’s contention that should the
critical vendor order be reversed, it would than have to file thousands of postpetition
preference actions to collect the critical vendor payments. The debtor then appealed to
the Seventh Circuit Court of Appeals.
4. SEVENTH CIRCUIT COURT OF APPEALS AFFIRMS THE DISTRICT COURT AND LIMITS THE CRITICAL VENDOR DOCTRINE
The Seventh Circuit Court of Appeals affirmed the district court's reversal of the
bankruptcy court’s approval of the debtor’s critical vendor motion. The Seventh Circuit’s
decision does not flatly reject the critical vendor doctrine, but it does indicate that a
debtor seeking authority to pay its critical vendors must be prepared to satisfy
heightened procedural and evidentiary standards. The Seventh Circuit noted that the
bankruptcy court ruling: “open-ended permission to pay any debt to any vendor it
deemed ‘critical’ in the exercise of unilateral discretion, provided that the vendor agreed
to furnish goods on ‘customary trade terms’ for the next two years — was ‘in the bests
interests of the Debtors, their estates and their creditors’” 1 was overbroad. In other
words, a debtor may not request broad authority to pay critical vendors at its request.
Rather, the debtor must identify which vendors are critical.
The Seventh Circuit found that a court should make a determination that discrimination
among unsecured creditors is the only way to facilitate reorganization, and that the
disfavored creditors were at least as well off as they would have been had the critical
vendor motion not been approved. The bankruptcy court in Kmart addressed neither of
these issues. The Seventh Circuit also stated that the non-critical vendors should have
received notice of the critical vendor motion, noting that of the thousands of creditors of
Kmart, only 65 creditors were noticed.
The Seventh Circuit's decision indicates that a bankruptcy court within this circuit may
1 Capital Factors Inc. v. Kmart Corp., 359 F.3d 866,868-69 (7
th Cir. 2004).
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grant a critical vendor motion pursuant to section 363 of the Bankruptcy Code, provided
the four elements (discussed in section 5 below) can be met. The Seventh Circuit
has fielded a large share of mega-chapter 11’s, such as Kmart and United Airlines,
which may require a debtor to reconsider a filing in the Seventh Circuit given the
heightened standard.
5. THE SUPREME COURT REQUESTS BY CREDITORS TO CONSIDER THE SEVENTH
CIRCUIT’S RULING IN KMART.2
The Seventh Circuit’s denial of certiorari (appeal) did little to clarify the uncertainty
regarding the critical vendor doctrine. In the Seventh Circuit, if a debtor seeks to pay
critical vendors, the debtor should seek an order pursuant to Section 363(b)(1) of the
Bankruptcy Code.
The debtor must establish:
(1) Such payments are in fact critical to their reorganization;
(2) Discrimination among unsecured creditors is the only way to facilitate a
reorganization;
(3) Non-critical vendors will be at least as well off as they would otherwise be if the
critical vendor order is not entered;
(4) Such payments will not diminish the amount of funds that ultimately will be
available for payment to non-critical vendors. In addition, the Seventh Circuit has
expressed concerns about notice of a critical vendor motion to non-critical
vendors.
A debtor should also provide broader notice of such motion so that non-critical vendors
have a better opportunity to respond to such motions. In the years following the Kmart
ruling, scrupulous debtors have worked with vendors in establishing the critical nature of
the product or service based on the heightened court scrutiny of critical vendor requests.
Also, given the split in the circuit courts, the Kmart ruling has prompted debtors to
consider filing bankruptcy petitions in favorable court venues that have declined to follow
the Seventh Circuit such as the district of Delaware and the Southern District of New
York.
2 Knight-Ridder, Inc. v. Capital Factors, Inc., WL 2050509; Handleman Co. v. Capital Factors, Inc., 2004 WL 2050510; Irving Pulp & Paper, Ltd. v. Capital Factors, Inc., 2004 WL 2068456.
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6. KMART’S CLAW BACK (REACH BACK) OF CRITICAL VENDOR PAYMENTS
In light of the reversal of the critical vendor order, Kmart demanded that critical vendors
return the critical vendor payments they received. Kmart was forced to sue hundreds of
vendors in an attempt to recover these transfers.
E. Special Issues with the Critical Vendor Doctrine
1. REORGANIZING VERSUS LIQUIDATING DEBTORS
As already pointed out, a central element of the critical vendor doctrine is that critical
vendors provide an essential product or service that, if provided, will assist the debtor’s
reorganization. If the debtor is liquidating its assets, the critical vendor doctrine is not
met, and such a request should be denied.
2. MAKING THE CRITICAL VENDOR LIST
A Chapter 11 debtor that is an operating business must decide which vendors they need
most, and then negotiate a payment. The debtor places the “critical” vendors on a list.
Those vendors that do not make the list will receive payment through a confirmed plan of
reorganization or Chapter 7 liquidation, often years after the filing, even after the
Bankruptcy Reform Act that pressures debtors to exit bankruptcy earlier.
The critical vendor motion is filed by the debtor with the bankruptcy court and provides
that the vendor will receive payment on the prepetition claim. The order approving the
motion also binds the vendor that agrees to critical vendor status to continue to sell with
the debtor on terms equal to or better than pre-petition terms. The responsibility to
define the vendors typically has been placed in the hands of the debtors. When a
company files for bankruptcy, it reviews a list of its vendors and decides which ones are
critical in order to stay in business.
Another strategy for a debtor is not identifying their critical vendors in court pleadings,
which are public documents, to avoid alienating those vendors who don’t make the list.
It seems the leverage of the critical vendor request may be shifting from the vendor to
the debtor. The vendor may hold out continued sales to the debtor thereby threatening
the debtor’s ongoing operations, perhaps only to find a replacement vendor who
qualifies as a critical vendor.
a. Proving-Up Your Critical Vendor Status (very important information)
Although the debtor files the motion with the bankruptcy court to approve critical vendor
status, following the Kmart decision vendors are expected to provide specifics for the
bankruptcy court, as well as creditors, as to why the vendor is so valuable to justify
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paying its claim ahead of other vendors. To that end, the vendor should review the
debtor’s motion to pay critical vendors and determine whether the debtor has classified
vendors. For example, if the debtor proposes to pay a class of vendors based on their
providing a unique product, the vendor should be prepared to provide documents or a
statement from a competent witness explaining the uniqueness of the product. Likewise,
if the debtor defines a class of vendors as critical based on their knowledge of the
debtor’s operations, the vendor should be prepared to provide documents or a statement
from a competent witness as to this unique relationship.
b. Dealing with the Automatic Stay
The automatic stay is an injunction that automatically and immediately goes into effect
upon the bankruptcy filing. It is filed, whether the bankruptcy filing is one under Chapter
7 or 11. The automatic stay prohibits any creditor from taking action against the property
of the estate and against the debtor, unless relief from the stay is obtained. For example,
a vendor is barred from seeking or levying writs of attachments or garnishments, and
also stays the vendor from a judicial lien against the debtor, but has not yet levied on any
property.
The creditor needs to be mindful when requesting critical vendor status that the manner
in which the request is made does not violate the automatic stay. To that end, the
creditor should consider contacting the customer (debtor) and determine who within the
company is responsible for the critical vendor program. Once that contact is identified,
the vendor may negotiate with the representative to make the list.
c. Timing of Critical Vendor Request:
(i) Prepetition Critical Vendor Request
A vendor may learn that a debtor is considering filing Chapter 11. To that end, a vendor
may approach the customer and request critical vendor status should the customer file
Chapter 11. The vendor may request the customer sign a contract recognizing that the
vendor would be deemed a critical vendor upon a Chapter 11 filing. Even if the customer
signs the contract, there is no assurance that the vendor will be given critical vendor
status. Creditors may object and the court ultimately must approve the request.
(ii) Postpetition Critical Vendor Request
A debtor usually requests bankruptcy court approval of its critical vendor motion as part
of its first day motions. The vendor should request that the debtor select them as a
critical vendor. The trend is for the debtor to request critical vendor approval of a claims
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cap. The debtor does not disclose the vendors it has selected as critical in its motion.
Rather, the debtor designates those vendors it deems critical after the court approves
the motion.
d. Alternatives to Immediate Payment in Full:
(i) Payments of Less than 100%
In a claims’ cap situation, a debtor may attempt to have its critical vendor dollars go
further by offering vendors only a percentage of their prepetition claims paid, for example
70%. There is no legal basis that requires a debtor to pay critical vendors 100% on their
prepetition claims.
(ii) Payments Over Time
Another alternative a debtor may offer to immediate payment in full of its critical vendors,
is to pay those vendors prepetition claims over time, for example over several months.
As with the percentage payment, there is no legal basis that requires a debtor to pay the
vendors’ prepetition claim immediately.
(iii) Cross-Collateralization Provisions
A debtor may insist that the critical vendor payments be paid through the vendor’s future
shipments. In other words, when the vendor ships postpetition, the debtor’s payment on
the postpetition sale pays down the prepetition debt. The vendor’s postpetition debt
builds up, which is entitled to administrative priority, and is ultimately paid down after the
prepetition debt is paid.
3. SELLING TO A CHAPTER 11 DEBTOR INVOICE BY INVOICE COMPARED WITH AN
EXECUTORY CONTRACT
A vendor that has sold a debtor on an order-by-order basis has no continuing obligation
to sell the Chapter 11 debtor. Because of this, the vendor has leverage on whether to
sell the debtor. An element of the debtor’s critical vendor request is that the vendor
provides a product or service that is indispensable for its continued operations. Should
the critical vendor decide not to provide the product or service, the prospects for the
debtor’s reorganization is diminished.
However, with the vendor who is a party to an executory contract, such as a long-term
supply contract, the debtor may seek to compel the vendor to comply with the terms of
the contract. The automatic stay bars the vendor that is a party to an executory contract
with the debtor from terminating the contract postpetition, without bankruptcy court
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authorization. Thus, only those vendors selling invoice by invoice should have the
leverage to seek critical vendor status. Having said that, debtors have given critical
vendor status to vendors that have executory contracts.
4. NON-CRITICAL CREDITORS AND SHAREHOLDERS VIEWPOINTS
a. Unsecured Creditors
A vendor who has not been selected by the debtor to be a critical vendor may oppose
the critical vendor motion. The vendor may complain to the bankruptcy court or debtor
that it is also willing to provide credit to the debtor postpetition in exchange for payment
on its prepetition claim. The reason that the unsecured creditor complains is that the
alternative to immediate payment is to often wait years for payment and eventually
receive a mere percentage of the amount owed. Indeed, a debtor may propose that the
creditor receive stock in the reorganized debtor on account of the prepetition claim.
With debtors now requesting approval of critical vendor motions without identifying which
vendors are critical, unsecured creditors are less like to object. Where a debtor has
requested a claims’ cap, the court may approve a pot of money to be paid to critical
vendors. The debtor thereafter selects vendors it deems critical. In this situation, the
vendor may be able to negotiate critical vendor standing.
b. Creditors’ Committee
In Chapter 11, the creditors’ committee comprises the major unsecured creditors of the
debtor and is a watchdog for the interests of all unsecured creditors of the debtor.
The creditors’ committee, if appointed, may object to the critical vendor proposal, or
request changes to amount requested, or the criteria for a vendor to qualify. A conflict of
interest may emerge where a committee member may also be considered as a
candidate for critical vendor status. A committee member in this situation should
abstain from voting on this request.
Before filing a critical vendor motion, a debtor should seek the support of the creditors’
committee. Bankruptcy courts are more willing to grant a motion if a creditors’ committee
does not object, or where there is an objection, if the debtor and creditors’ committee
can reach a compromise over such issues as the degree of oversight of critical vendor
payments.
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c. Bondholders and Unsecured Bank Debt
Bondholders and unsecured bank debt holders may oppose a critical vendor proposal,
as the bonders and unsecured bank debt holders do not get such preferred treatment
even though they would share pro rata any payments under a plan of reorganization.
The bondholders are likely trapped creditors that will not provide the debtor any
postpetition financing and thus not qualify as a critical vendor. Therefore, they complain
that this class of creditor is unjustifiably preferred.
d. Asbestos and Mass Tort Claimants
Like the bondholder and unsecured bank debt holder, the asbestos and mass tort
claimant may protest the preferred treatment of a critical vendor given that they may be
treated as an unsecured creditor if their claim has been settled. Alternatively, the
asbestos claimant may be grouped under a trust for payment and therefore see key
vendors continuing to supply the debtor as central to maximizing the prospects for a
debtor to exit Chapter 11.
e. Office of the United States Trustee
As an adjunct to the Justice Department, the Office of the United States Trustee is in a
position to object to the critical vendor motion. The U.S. Trustee may oppose the critical
vendor request if it is made in the opening days and creditors have not had an
opportunity to respond.
5. PERSUADING THE BANKRUPTCY COURT
The bankruptcy court must approve a debtor’s critical vendor motion. Even if no party
objects to the motion, the court may deny the request. In light of Kmart, a debtor
requesting approval of a critical vendor motion in the Seventh Circuit will include the
elements considered by the Seventh Circuit (previously mentioned). However, debtors
requesting approval of critical vendor motions outside of the Seventh Circuit will have to
look to recent decisions in the district of their bankruptcy court for guidance.
a. Regional Divide between Bankruptcy Courts
Depending on the district, bankruptcy courts either tend to approve or tend to reject
motions for critical vendor payments. While bankruptcy courts in Delaware and New York
have applied lenient criteria in regularly approving critical vendor motions, other
bankruptcy courts, including those in Kentucky and Georgia, have adopted and further
developed the criteria from the Kmart opinion in limiting critical vendor motions.
b. Delaware
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In Deleware, bankruptcy courts have granted motions permitting payment for prepetition
claims for critical vendors while imposing conditions on the terms of the repayment. In the
2009 chapter 11 bankruptcy for Foamex International Incorporated3 (Foamex), the debtor
moved to honor prepetition obligations with certain critical vendors in the district of Delaware.
Citing cases pre-dating Kmart including Ionosphere4 and Just for Feet5, Foamex targeted
prepetition obligations to chemical, cloth, maintenance, repair, and operations suppliers.
Relying on sections 363(b) and 105(a), the court granted Foamex's motion, noting that by
accepting payment, a vendor was agreeing to provide goods and services on the same terms
that were in place prepetition. The court further noted that if a vendor refused to abide by
prepetition times, the estate may recover the payment.
Deleware bankruptcy courts have gone so far as to order prepetititon payments for a critical
vendor against the debtor’s wishes. In 2007, the Delaware bankruptcy court presiding over In
re Orion Refining Corp. found in favor of a vendor seeking to enforce an agreement by the
debtor to pay prepetition claims6. The vendor contended that the debtor had agreed to pay
prepetition claims in full in exchange for both performing repair services at the debtor’s place
of business and continuing to accept work orders. The bankruptcy court determined that
despite the absence of a written agreement, the parties had formed an enforceable
agreement. Therefore, the debtor’s refusal to pay the vendor for its services constituted a
breach of the agreement. The bankruptcy court ordered full payment of prepetition claims and
went so far as to modify the pre-existing cap of critical amounts payable to allow for the
payment.
c. New York
In 2009, Charter Communications, Inc. (Charter) filed a motion in its Chapter 11 bankruptcy in
the Southern District of New York to authorize payment of prepetition claims in the ordinary
course of business under sections 363(b)(1) and 105(a)7. Charter contended that the
uninterrupted supply of goods and services provided by the selected trade creditors was
essential to the continued success of the company. The court granted Charter's motion but
limited from the order relief for any reduction or offset of intercompany accounts. Notably, the
court did not specify that vendors had to act in accordance with the prepetition course of
3 In re Foamex Int'l, Inc., No. 09-10560, 2009 Bankr. LEXIS 4945 (Bankr. D. Del. Feb. 20, 2009).
4 In re Ionosphere Clubs, Inc., 98 B.R. 174, 175 (Bankr. S.D.N.Y. 1989).
5 In re Just for Feet, Inc., 242 B.R. 821, 822 (Bankr. D. Del. 1999).
6 In re Orion Refining Corp., 372 B.R. 688 (Bankr. D. Del. 2007). 7 In re Charter Commc'ns., Inc., No. 09-11435, 2009 Bankr. LEXIS 5207 (Bankr. S.D.N.Y. Apr.
15, 2009).
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dealing. However, vendors in similar situations looking to alter payments from prepetition
terms to their advantage should proceed with caution to avoid the risk of creating grounds for
the withholding or disgorgement of payments made under the order.
In 2005 in the Southern District of New York, Delphi Corporation (Delphi) filed several related
motions regarding pre-petition claims its in Chapter 11 bankrutpcy8. The debtor worked out a
compromise with the committee of creditors, which had laid out of several objections to the
motion. The court approved pre-petition payments subject to the debtors reporting to the
committee of creditors on a monthly basis and seeking immediate approval for transactions
greater than one million dollars.
c. Regions outside of New York and Delaware
In 2009, a bankruptcy court in the Western District of Kentucky applied a variation of the
Kmart critera in reviewing a critical vendor motion in Corner Home Care Inc.’s chapter 11
bankruptcy9. The court applied a strict three-part test that required the debtor to prove 1) the
vendor was necessary for reorganization 2) the debtor was exercising sound business
judgment in selecting the vendor and 3) the debtor was not prejudicing other unsecured
creditors by favoring the selected creditor. In denying critical vendor treatment for creditor
H.D. Smith, the court noted that the debtor was unable to prove the creditor’s unwillingness to
sell their product on any possible terms, such as cash terms. Moreover, other vendors had
indicated a willingness to sell identical goods on a cash basis. Additionally, the court found
that the debtor failed to exercise sound business judgment when making payments on
prepetition accounts of over $140,000 without obtaining an agreement with the vendor for
continued services over an extended term. Finally, the court determined that the debtor had
failed to prove the absence of prejudice against other creditors, especially where other
creditors had objected to the unfavorable treatment and claimed a willingness to provide
identical services.
In 2013, the Northern District of Georgia adopted a test similar to the one outlined in Kmart for
critical vendor motions in the News Publishing Company chapter 11 bankruptcy10. The
debtor was unable to satisfy the bankruptcy court’s three part test requiring proof of 1) the
necessity of the prepetition payments for the debtor’s reorganization 2) the vendors’ refusal to
8 In re Delphi Corp., Ch. 11 Case No. 05-44481 (Bankr. S.D.N.Y. Oct. 8, 2005).
9 In re Corner Home Care, Inc., 438 B.R. 122 (Bankr. W.D. Ky. 2010).
10 In re News Publ'g. Co., 488 B.R. 241 (Bankr. N.D. Ga. 2013).
https://advance.lexis.com/api/document/collection/cases/id/57YV-CDH1-F049-1045-00000-00?context=1000516https://advance.lexis.com/api/document/collection/cases/id/57YV-CDH1-F049-1045-00000-00?context=1000516
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continue to provide services without critical vendor payments 3) non-prejudicial treatment of
other unsecured creditors. Despite testimony from the debtor’s president in support of the
critical vendor motion, the court rejected prepetition payments for all of the vendors except a
staffing agency that supplied employees to the debtor. The court pointed out that the vendors
had not expressed an unwillingness to continue business on any level, such as cash terms, if
prepetition payments were not made, nor had the debtor stated how the payments were
necessary to the debtor’s reorganizations. Moreover, the court found the president’s
testimony regarding the creditors’ unwillingness to do business vague and unsubstantiated.
d. Takeaway
In the years following Kmart, bankruptcy courts in New York and Delaware have typically
approved vendor motions brought under section 363(b)(1) and 105(a) when supported
by evidence such as testimony from the debtor's key personnel. Where corporate
officers, such as CFOs, have testified to the necessity of a critical vendor to the debtor’s
reorganization and an absence of alternative vendors, the court has acquiesced to the
debtor’s business judgment. Still, a favorable order for prepetition payments to critical
vendors may be contingent on the creditors’ committee approval and oversight. Debtors
should work with the creditors’ committee and seek prior approval from the U.S. Trustee
and post-petition lenders to avoid objections to the motion. Upon entry of an order
approving critical vendor payments, vendors should abide by the terms of the agreement
with the debtor or risk court ordered disgorgement of the prepetition payment.
Outside of New York and Delaware, bankruptcy courts have stringently applied tests in
the vein of the Kmart test much to the dismay of debtors and potential critical vendors.
In paritcular, debtors have struggled to adequately demonstrate the necessity element.
Debtors would be well advised to collect and document evidence that critical vendors are
unwilling to continue to do business on prepetition terms or any other terms, such as on
a cash basis. Debtors should substantiate assertions that affordable alternatives to the
vendor are unavailable. When a debtor can prove a critical vendor is both necessary
and unique, courts have determined there is no prejudice against other creditors
because the debtor’s estate is maximized and even the disfavored creditors will
ultimately receive greater payments on their respective claims.11
11
In re Tropical Sportswear Int’l Corp., 320 B.R. 15 (Bankr. M.D. Fla. 2005).
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6. 503(B)(9) CLAIMS AND EARLY PAYMENT IN EXCHANGE FOR TRADE CREDIT Following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act
(“BAPCA”) of 2005, there was a new type of administrative priority claim established under §
503(b)(9). The § 503(b)(9) claim presents an opportunity for vendors to recover where there
might not have been one otherwise. To succeed on a § 503(b)(9) claim, a vendor must prove:
a) that it sold goods to the bankrupt customer; b) that these goods were received by the debtor within 20 days prior to the
bankruptcy filing; c) that goods were sold in the ordinary course of the debtor’s business; and d) the value of the goods that were sold to the debtor12
As such, § 503(b)(9) gives vendors an administrative priority claim for “the value of any goods
received by the debtor within 20 days” before the bankruptcy petition date as long as the
goods were sold to the debtor “in the ordinary course of such debtor’s business.”13 On
occasion, a vendor may find that the product or service they provided to the customer
prepetition is necessary and key to the debtor’s continued operations. If the product or
service is unqiue in any way, the vendor may have some leverage when conducting
negotiations in the post-bankruptcy sales. In this situation, the debtor may request that the
bankruptcy court allow it to immediately pay the vendor’s prepetition claim in the opening
days of the case, in exchange for the vendor selling to the debtor post-bankruptcy on
comparable credit terms for the duration of the bankruptcy case.
A vendor can certainly claim critical vendor status as opposed to settling for a § 503(b)(9)
claim. The former allows for some form of payment plan for all the pre-petition amounts
owed, whereas the latter only deals with the goods sold within the 20-day period before the
petition date. However, the more § 503(b)(9) claims there are, the less funds are available to
pay the critical vendors. Since the development of § 503(b)(9), courts are less inclined to
grant critical vendor status .
However, in order to ensure payment of their entire pre-petition amount, a vendor with a §
503(b)(9) claim may still prefer the critical vendor status. Although, vendors are generally
required to extend credit terms in exchange for attaining critical vendor status. Section
503(b)(9) claimants can also use the critical vendor status to ensure a payment plan option
for the pre-petition balance or allowing a discount to the debtor. If the payments from the
12 11 U.S.C. § 503(b)(9) (2008). 13 Id.
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debtor have been made under the ordinary course, it is possible that a § 503(b)(9) claim will
be covered for the critical vendors on all the owing pre-petition amounts.
7. POSTPETITION CREDIT SALES: HOW MUCH CREDIT AND TERMINATING THE CREDIT RELATIONSHIP
The Bankruptcy Code does not specify the amount of trade credit the vendor must
provide to qualify as a critical vendor. However, debtors customarily condition critical
vendor status on the vendor providing comparable credit terms that the vendor provided
within the year prior to the bankruptcy filing. Generally, the debtor forwards a letter
agreement reciting the terms of the postpetition agreement.
Recent trade credit agreements approved by courts have required vendors to provide
postpetition credit through confirmation of the Chapter 11 proceeding. If the vendor
breaches the postpetition credit agreement, that may be cause for the vendor to
disgorge the payment on account of the prepetition claim.
If the postpetition trade credit agreement does not contain a provision that allows for the
vendor to terminate the trade relationship should the debtor fail according to the credit
terms, the vendor should write in such a provision. Further, the vendor may want
to include a provision that permits the vendor to terminate the trade relationship if the
debtor falls below key ratios, even if the debtor has not defaulted on the postpetition
credit agreement. This would allow the vendor to hold orders in the face of a debtor’s
deteriorating financial condition.
8. WAIVING ALLEGED PREFERENCE CLAIMS
A vendor that is deemed critical may find that it had already been paid on a portion of its
prepetition claim during the preference period. Even though the vendor may be deemed
a critical vendor, that designation does not protect the critical vendor from a preference
suit for payments received during the preference period.
A vendor may consider insisting on a preference waiver as part of being appointed
as a critical vendor. The court should approve the preference waiver.
9. INTERPLAY OF RECLAMATION
Article 2 of the Uniform Commercial Code, and the Bankruptcy Code, recognize that a
vendor may be permitted to reclaim goods that were shipped within a specified time
period of the bankruptcy filing. Most bankruptcy courts recognize that reclaiming
creditors are entitled to administrative priority. Under the critical vendor doctrine, many
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20
debtors will pay vendors their prepetition claims that are not reclamation claims, which
are entitled to administrative priority. The reclamation claims will be paid pursuant to a
global reclamation order.
10. A DEBTOR’S OR TRUSTEE’S RIGHT TO CLAW BACK CRITICAL VENDOR PAYMENTS UPON REVERSAL OR CONVERSION TO CHAPTER 7
Kmart has raised the issue of whether a vendor that is selected as a critical vendor may
later be sued to recapture the critical vendor payment in the event the critical vendor
order be reversed, even if the vendor extended credit to the debtor as required under the
critical vendor order. A vendor should consider including a provision in the critical vendor
order that bars a claw back of the critical vendor payment should the order be reversed.
The most effective way to gauge this risk is whether the critical vendor order was
appealed. The general rule is that the critical vendor order must be appealed within 10
days of entry. Should a party fail to timely do so, the appeal is lost.
Does the critical vendor face risk that the critical vendor payment may be clawed back if
the Chapter 11 be converted to Chapter 7 liquidation? If the critical vendor order
provides that the vendor is free from such claims if the case converts from a Chapter 11
to a Chapter 7, that language should protect the vendor from any later claims asserted
by a Chapter 7 trustee.
11. FAILING TO QUALIFY AS A CRITICAL VENDOR; OR, THE CRITICAL VENDOR PROGRAM IS NOT APPROVED
a. Selling on Credit Postpetition
To encourage vendors to sell a debtor postpetition on credit, the Bankruptcy Code
provides that should the debtor default on the credit sale, the vendor is entitled to an
administrative claim for the unpaid balance. Unlike the critical vendor doctrine, a
postpetition credit sale does not allow for payment on the vendor’s prepetition claim.
b. The Catch Up Issue
If the vendor does not qualify as a critical vendor, the vendor may decide to find an
alternative to have its prepetition claim paid. A vendor may not be paid on its prepetition
claim post bankruptcy. However, a creditor may attempt to have the debtor pay down its
prepetition debt by inflating its postpetition invoices. This “catch up” scheme may be
illegal, and can result in disgorgement of the inflated invoices and, possibly, criminal
action.
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c. Junior Lien Sales
To those vendors who do not qualify as critical, a debtor may offer a junior lien on assets
in exchange for their selling on credit. The purpose of the junior lien is to reduce the risk
that if the debtor fails to pay for the credit sale, the vendor may have some assets
to look to for payment. However, the junior lien sale does not pay a vendor’s prepetition
claim. Therefore, this alternative is more risky for the vendor.
d. Sale of Claim
A vendor that is not selected as critical may elect to sell its prepetition claim. Third
parties, unrelated to the debtor, offer to purchase a trade creditor’s prepetition claim, at a
discount. Unlike the critical vendor doctrine, a vendor does not have a continuing
obligation to sell the debtor on credit when it sells its claim to a third party. Also, unlike
the traditional critical vendor doctrine, a vendor selling its claim does so usually at a
steep discount.
12. OTHER CONSIDERATIONS FOR A CRITICAL VENDOR
a. Is it Worth It?
Critical vendors are, by definition, imperative to the continued operation of the debtor
company. But identifying whether the debtor’s business is necessary to the vendor’s viability
may be an equally critical calculation to the vendor. In making this assessment, vendors
should compare the relative size of their pre-petition claim versus the post-petition credit
exposure that may result from an administratively insolvent case or from a clawed back
payment in a trustee suit. The vendor should also consider whether the debtor anticipates a
100 percent payout plan. If the risks outweigh the benefits, a vendor may consider moving
on and cutting its losses.
F. Conclusion
The application of consistent and standardized rules governing the critical vendor
doctrine continues to take shape. Regional differences between bankruptcy courts
regarding the approval of critical vendor payments continue to solidify and provide some
direction for debtors seeking critical vendor friendly courts. But until the United States
Supreme Court rules on this issue, or Congress intercedes, a debtor's ability to obtain
authorization to make critical vendor payments may vary from court to court and district
to district. A debtor seeking this relief, and creditors working with debtors to seek this
relief, should rely on more than mere equitable grounds as authority, and present more
evidence that the critical vendor is truly indispensable to the debtor's continued business
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22
and reorganization.
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23
Exhibit A: Pre-bankruptcy Critical Vendor Agreement
CRITICAL SUPPLIER AGREEMENT
THIS AGREEMENT between [vendor] ("[vendor]") and [customer], a _____________ corporation (“[customer]”) takes effect on __________ __, 201_.
Background:
[vendor] is a supplier of one or more necessary and critical products or services that [customer] uses in connection with its operations. Without this product or service, [customer] would face a possibly irreparable impact on its ability to continue operations and retain customers. [customer] 's recent purchases of this product or service from [vendor] on open account has averaged approximately $________ on a monthly basis. [customer] has asked [vendor] to continue to extend credit to [customer] to permit [customer] to continue to purchase this product or service on open account and, in addition, to extend ___ day payment terms to _______________. Subject to the terms and conditions of this agreement, [vendor] is willing to extend this additional credit to [customer] for an agreed time period in consideration of entering into and performing this agreement.
The Agreement:
In consideration of the covenants and agreements herein contained, the parties agree:
1. The recitals above are made a part of this agreement.
2. [customer] agrees that if a bankruptcy proceeding is instituted or a finding that [customer] is adjudicated a debtor as a result of an involuntary petition filing, then [customer] will use its best efforts to seek full relief for [vendor] as a "critical supplier" or "critical vendor" of [customer].
3. [vendor] agrees to extend __-day payment terms to _______________ through
____________, 201_. [customer] agrees that its strict compliance with such payment terms constitutes a fundamental term of this agreement and that its failure to so comply constitutes a material breach of this agreement. Notwithstanding anything to the contrary contained herein, [customer] agrees that if a Proceeding occurs and the appropriate court does not designate [vendor] as a "critical supplier" or "critical vendor" and order payment of [vendor]'s pre-Proceeding debt, [vendor]'s obligation to extend credit and such payment terms in connection with post-Proceeding sales to [customer] is null and void without prior notice. [Customer] further agrees that these provisions and any deemed termination or modification thereof are not conditioned on any of the events or conditions referred to in section 365(e) of the U.S. Bankruptcy Code or any similar law.
4. [Vendor] agrees to waive its rights under section 365(c)(2) of the U.S. Bankruptcy Code
provided [vendor] is named a critical vendor and paid as to its prepetition claim within 30 days of the Chapter 11 filing.
5. [Vendor] can in its sole discretion terminate its postpetition credit line if it becomes financially
insecure with [customer] ability to honor the terms of the postpetition credit sales.
6. No waiver by [vendor] of any default shall be effective unless in writing nor shall it operate as a
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24
waiver of any other default or of a similar default on a subsequent occasion. [vendor] has the right at
all times to enforce the provisions of this agreement in strict accordance with the terms hereof,
notwithstanding any conduct or custom on the part of [vendor] in refraining from so doing at any time
or times. The failure of [vendor] at any time or times to enforce its rights under said provisions strictly
in accordance with the same shall not be construed as having created a custom in any way or
manner contrary to the specific provisions of this agreement or as having in any way or manner
modified the same.
7. This agreement is governed by, and shall be construed in accordance with, the law of [vendor’s location], without reference to conflicts of law principles.
8. This agreement may be executed in any number of counterparts each of which when executed and delivered will be an original, but all the counterparts together will constitute one and the same instrument.
Dated: _______________________
ATTEST [vendor] COMPANY ______________________________ _________________________________
ATTEST [customer]
______________________________ _________________________________
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Exhibit B: Post-bankruptcy Critical Vendor Agreement
[ DEBTOR ]
_____________, 201_
TO: [Critical Trade Vendor] [Name] [Address] Dear Vendor: As you are no doubt aware, [DEBTOR NAME] and certain of its affiliates (“Debtors”), filed a voluntary petition under chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy court for the District of _______________ on _________________ (the “Petition Date”). On the Petition Date, we requested the Bankruptcy court’s authority to pay certain suppliers. On _________201_, the Bankruptcy Court authorized us to pay prepetition claims of certain trade creditors that agree to the terms set forth and to be bound by the terms of the Order. In order to receive payment on prepetition claims, each selected trade creditor must agree to continue to supply goods to the Debtors based on “Customary Trade Term.” Customary Trade Terms are defined as the normal and customary trade terms, practices and programs (including, but not limited to, credit limits, pricing, cash discounts, timing of payments, allowances, rebates, coupon reconciliation, normal product mix and availability and other applicable terms and programs) in effect between such trade creditor and the Debtor for the period prior to the Petition Date or such other trade terms that are at least as favorable as those that were in effect during such time. For purposes of administration of this trade program as authorized by the Bankruptcy court, the Debtors and you agree as follows: 1. The balance of the prepetition trade claim (net of any setoffs, credits or discounts) (the “Trade Claim”) that the Debtor will pay you is $__________________. 2. You will provide open credit terms as follows: _________________________________________________________________________________ 3. The open trade balance or credit line that you will extend to the Debtor for shipment of postpetition goods is $___________ : ((a) on __________201___, or; (b) on normal and customary terms on a historical basis for the period immediately before the Petition Date). 4. Payment of your claim may only occur upon execution of this letter by a duly authorized representative of your company and the return of this letter to the Debtor. Sincerely, [Applicable Debtor] By: ____________________________
Its:_________________________- Agreed and Accepted by: [Name of Trade Vendor] By: __________________________
Its:________________________ Dated: ________________________
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